Fed Affirms Plan to End Mortgage Intervention

Business and Finance Career - The Federal Reserve on Tuesday affirmed its plan to stop buying mortgage-backed securities, expressing a degree of confidence that it could eliminate that pillar of support without undermining the nation’s economic recovery.

The move came as the Fed voted to keep its benchmark interest rate unchanged, at nearly zero percent, citing evidence of economic weakness and little sign of inflation.

The Fed’s purchases of mortgage-backed securities, which will total $1.25 trillion and end March 31, have helped hold mortgage rates to near-record lows, and the Fed left open the possibility that the purchases might have to be resumed, particularly if the housing recovery stalls.

The Fed said it would “continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”

Marvin Goodfriend, a former research director at the Federal Reserve Bank of Richmond, said the Fed was essentially conducting an experiment by trying to end its purchases of mortgage securities. “It would like private money to come back into the mortgage market, but if the interest-rate spread on mortgages over government securities that is needed to bring private money back is too high, it could impede the recovery of the housing market,” he said.

Ideally, the Fed would like to see only a slight rise in mortgage rates, he said.

In announcing that it would hold its benchmark fed funds rate near zero, the Federal Open Market Committee, the Fed’s chief policy-setting arm, said that “the labor market is stabilizing.”

That was a slight improvement over the assessment given after the Fed committee’s last meeting, in January, when it said “the deterioration in the labor market is abating.”

The committee added: “Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit. Business spending on equipment and software has risen significantly.

“However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls.”

The committee maintained its position that “inflation is likely to be subdued for some time,” and left the target range for the fed funds rate, the rate that banks make overnight loans to each other, at zero to 0.25 percent, where it has been since December 2008.

And as it has said since last March, the committee projected that the rate would probably remain “exceptionally low” for “an extended period.” Many economists have taken that language to mean that the Fed would not begin tightening monetary policy until the second half of this year.

As of last week, the Fed has bought just over $1 trillion in mortgage-related assets, through a program that started in November 2008. It also had bought, as of Wednesday, $169 billion out of a target of $175 billion in debt guaranteed by federal mortgage-financing agencies, primarily Fannie Mae and Freddie Mac.

Stephen H. Axilrod, a retired Fed official and the author of “Inside the Fed,” a book about monetary policy, said of the committee members: “They’re gathering the nerve to end this response to the crisis and revert to normal, which is not to buy large amounts of long-term securities to lower interest rates.”

But Ian Shepherdson, the chief United States economist at High Frequency Economics, a forecasting company, said the end of the asset purchases would “expose M2,” a measure of the money supply, “to the full force of the credit contraction, and it won’t be pretty.”

He wrote in a research note: “The Fed reserves the right to buy assets again if needed; we think it will have to.”

Mr. Goodfriend, now a professor of economics at the Tepper School of Business at Carnegie Mellon University, said: “The Fed can’t fund the mortgage market forever. There has to be an exit where the Fed pulls out, lets the spread move around a little, and assures investors that they can get a return commensurate with the current risk in housing.”

So far, the gradual tapering off of the purchases has not had a major effect on mortgage interest rates, which many Fed officials view as an encouraging sign.

The committee approved its public statement by a vote of 9 to 1. Thomas M. Hoenig, the president of the Federal Reserve Bank of Kansas City, who is known for his wariness about inflation, dissented, as he did in January.

Mr. Hoenig “believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability,” the Fed said in its statement.

With interest rates unable to go any lower, the Fed has had to use other instruments of monetary policy to help stimulate growth. Chief among those tools has been the asset purchases.

“The Fed, if it wanted to, and it may yet need to, could continue buying assets and expanding its balance sheet,” Mr. Goodfriend said.

“That’s an option the Fed has, even though interest rate policy is immobilized at zero. The reason we have a central bank is that it retains flexibility to move in either direction, depending on what the economy requires. It needs to make the most of that flexibility, because it’s very hard to see the future.”

The Fed also injected liquidity into the markets by making huge amounts of loans at the peak of the financial crisis in 2008.

Less than a month ago, the Fed took steps to normalize lending by raising the interest rate it charges on short-term loans to banks to 0.75 percent, from 0.50 percent.

While the Fed emphasized that the change in the discount rate did not represent a shift in monetary policy, it was interpreted by some as a clear sign that an extraordinary era of easy money was going to end gradually.